Investing in Taxable Accounts vs. IRAs ? Getting Your Financial ...

When investing beyond an employer-sponsored retirement plan, you have a choice to make, between using an IRA, a Roth IRA, or a taxable, non-deferred investment account.? In making this choice your primary consideration should be the tax implications.

It?s easy to understand the current tax implications: if you invest in a traditional IRA and your contributions are deductible, you are saving the income tax of the deductible contribution.? In all other choices, there is no current tax impact.? For non-deductible contributions to a traditional IRA, or regular contributions to a Roth IRA, or saving in a taxable account, you are paying income tax as you?ve earned the money, regardless of what you do with it.

The second area to consider tax implications on all of these types of accounts is when there is income produced from the investments within each type of account.? Income produced includes capital gains from sales as well as dividends and interest.? In an IRA or Roth IRA, when income is produced there is no tax impact, as all tax is deferred.? In the case of the taxable investment account there is current impact in terms of dividend taxation or capital gains tax.? Presently capital gains are taxed at a maximum rate of 15% ? but this could change, depending upon what Congress decides to do.

Many investments in taxable accounts can maintain tax deferral until you sell the security.? Mutual funds often distribute capital gains annually, but stocks and ETFs often don?t produce capital gains until you sell the security ? so you don?t have to recognize the income until you?re ready to sell.

The other, most important, impact is the rate of tax on your distributions over time.? With your taxable account, again you are only subject to the capital gains tax (today at maximum 15%), while in a traditional IRA your deductible contributions and growth on the account will be subject to ordinary income tax rates.? These rates max out at 35% (in 2012) but could be as high as 39.6% if the rates are increased in 2013 (and possibly higher).

Roth IRA distributions (as long as they?re after age 59?) have no tax at all ? and the same goes for non-deductible contributions to your traditional IRA.? Of course, since the non-deductible contributions are likely mixed in with growth and deductible contributions, so the non-taxed portions will be pro-rated with the entire distribution.

With all of this in mind ? over the longer term it is very important to put as much of your savings as you can into Roth-type accounts, and then as your current tax situation requires, put money into tax-deferred accounts and/or taxable investments.? For most folks, in the long run, the taxable accounts prove to be the best option to choose ? at least under current tax law.

Click the link to pick up a copy of An IRA Owner's Manual or if you'd prefer the Kindle version (and let's face it, ALL the cool kids do!), you can find that at this Kindle version link.

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I can learn from you, you can learn from me - please leave your comments and links!?Jim Blankenship, CFP?, EA, is an expert in personal retirement, IRAs, and tax issues, with more than 25 years of experience in the industry. Read more from this author

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